[Federal Register Volume 63, Number 43 (Thursday, March 5, 1998)]
[Proposed Rules]
[Pages 10785-10792]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-5728]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 230
[Release No. 33-7511; File No. S7-5-98]
RIN 3235-AG21
Rule 701--Exempt Offerings Pursuant to Compensatory Arrangements
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The current dollar limitations on the amount of securities
that may be offered and sold under the Commission's Rule 701 under
Securities Act of 1933 which provides an exemption from registration
for such securities pursuant to compensatory benefit arrangements may
be too restrictive. Therefore, we propose to amend these limitations to
permit companies greater access to the exemption if certain disclosure
requirements are satisfied.
DATES: Public comments should be received on or before May 4, 1998.
ADDRESSES: Please send three copies of the comment letter to Jonathan
G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549. You can send comments
electronically to the following e-mail address: rule-comments@sec.gov.
The comment letter should refer to File No. S7-5-98; if e-mail is used
please include the file number in the subject line. Anyone can inspect
and copy the comment letters at our Public Reference Room, 450 Fifth
Street, N.W., Washington, D.C. 20549. We will post comment letters
submitted electronically on our Internet site (http://www.sec.gov).
FOR FURTHER INFORMATION CONTACT: Richard K. Wulff (202-942-2950),
Office of Small Business, Division of Corporation Finance, Securities
and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C.
20549.
[[Page 10786]]
SUPPLEMENTARY INFORMATION:
I. Executive Summary
Rule 701 1 under the Securities Act of 1933
(``Securities Act'') 2 was adopted in 1988 to allow private
companies to sell securities to their employees without the need to
file a registration statement in the same manner as a public company.
At that time we determined that it would be an unreasonable burden for
these private companies, many of which are small businesses, to incur
the expenses and disclosure obligations of public companies when their
only public sales were to employees. This is especially true because
these sales were for compensatory and incentive purposes, rather than
capital-raising. To accommodate these companies, we used the maximum
extent of our exemptive authority and exempted offers and sales of up
to $5 million per year.
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\1\ 17 CFR 230.701.
\2\ 15 U.S.C. 77a et seq.
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Over the years, the Commission staff monitored the use of the rule.
Until mid-1993, Form 701 was required to be filed with us whenever an
offering under the rule was made. On the basis of that data and
feedback from practitioners, the staff has concluded that the rule has
been popular for both small businesses and larger private companies
(such as mutual insurance companies, foreign issuers, and engineering
firms), but that the $5 million limit has been particularly restrictive
in light of: the popularity of equity ownership by employees;
inflation; and the growth of deferred compensation plans (which are
eligible for the rule). In addition, the staff has concluded that the
rule needs further simplification and clarification.
In October 1996, Congress enacted the National Securities Markets
Improvement Act of 1996 (``NSMIA'') 3 which, for the first
time, gave us the authority to provide exemptive relief beyond $5
million for transactions such as these. The legislative history of
NSMIA suggested specifically that the $5 million ceiling on Rule 701 be
lifted.4 As detailed below, we propose today to modify the
ceilings and to further simplify and streamline the rule. To ensure
continued investor protection along with the added flexibility, we
propose to mandate that a company must give any purchaser specific
types of disclosure.
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\3\ Pub. L. 104-290, 110 Stat. 3416 (October 11, 1996).
\4\ Both Committee Reports specifically highlighted the current
$5 million limit contained in Rule 701 and seek prompt Commission
action to raise that ceiling. H.R. Rep. No. 104-622 at 38; S. Rep.
No. 104-293 at 16.
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We seek to increase the flexibility and utility of Rule 701 by
issuing proposals that would:
(1) Remove the artificial $5 million ceiling and instead set the
maximum amount of securities that may be sold in a year at the greatest
of:
$1 million;
15% of the issuer's total assets; and
15% of the outstanding securities of that class
(2) Not count offers for purposes of calculating the ceiling;
(3) Require the issuer to disclose certain risk factors that may be
associated with investment in securities pursuant to the plan or
agreement, and deliver financial statements in accordance with Form 1-A
of Regulation A 5 to each person to whom securities are
sold;
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\5\ 17 CFR 230.251-263.
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(4) Amend Rule 701 to comport with current and more flexible
interpretations; and
(5) Simplify the Rule.
Together, these changes will add greater flexibility for companies
to sell securities to their employees and, at the same time, will
provide that essential information be delivered to employees in a
timely manner.
II. Background
Rule 701 was adopted under section 3(b) of the Securities Act to
provide an exemption from the registration requirements of that Act for
offers and sales of securities pursuant to certain compensatory benefit
plans or written agreements relating to compensation.6 The
exemptive scope covers securities offered or sold pursuant to a plan or
agreement established by a non-reporting (``private'') company, its
parents or majority-owned subsidiaries, to their employees, directors,
partners, trustees, consultants and advisors.
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\6\ Release No. 33-6768 (April 14, 1988) [53 FR 12918].
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Currently the rule provides that the amount of securities that may
be subject to outstanding offers in reliance on Rule 701 plus the
amount of securities offered or sold under the rule in the preceding 12
months may not exceed the greater of $500,000, or an amount determined
under one of two different formulas. One formula limits the amount to
15% of the issuer's total assets measured at the end of the issuer's
last fiscal year. The other formula restricts the amount to no more
than 15% of the outstanding securities of the class being offered.
Regardless of the measurement method elected, the Rule restricts the
aggregate offering price of securities subject to outstanding offers
and sold in the preceding 12 months to no more than $5 million.
A. Concerns With the Current Rule
In the decade since adoption of Rule 701, equity ownership by
employees has grown exponentially. Not only have employees benefited
generally as the value of their stock has appreciated, but companies'
managements have widely encouraged equity participation as a retention
and incentive device for employees. In addition, companies have sought
to provide tax benefits and possible investment opportunities by
offering many of their senior and middle management personnel
participation in deferred compensation plans. To the extent these plans
involve an offer of securities, they are eligible to use Rule 701. The
growth of these plans, coupled with the impact of inflation, has caused
the $5 million annual limit to be impractical for many companies.
In addition to concerns with the ceiling, a myriad of interpretive
questions have arisen under the current rule. While every new rule
needs routine interpretive gloss from the Commission staff, Rule 701
has been the subject of an abundance of highly technical requests for
clarification. Some of these issues include how to treat stock options,
former employees, subsidiaries, consultants, advisors, and successor
issuers, and when to integrate Rule 701 offerings with other exempt
offerings under the federal securities laws. In summary, the rule needs
to be both simplified and modernized.
B. National Securities Markets Improvement Act of 1996
In October 1996, NSMIA was signed into law. Title I of that statute
relating to ``Capital Markets'' adds section 28 to the Securities Act
providing us with general exemptive authority from any provision of the
Securities Act.7 During the legislative process, both the
House Committee on Commerce 8 and the Senate Committee on
Banking, Housing and Urban Affairs 9 noted, in
[[Page 10787]]
considering this provision, that we should take steps to increase the
ceilings in our existing exemptions promulgated under section 3(b) of
the Securities Act. The legislative history of NSMIA reflects a
specific Congressional concern about the current $5 million aggregate
offering price ceiling in Rule 701 having a negative impact for many
issuers of securities in compensatory arrangements.
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\7\ The Commission, by rule or regulation, may conditionally or
unconditionally exempt any person, security, or transaction, or any
class or classes of persons, securities, or transactions, from any
provision or provisions of this title or of any rule or regulation
issued under this title, to the extent that such exemption is
necessary or appropriate in the public interest, and is consistent
with the protection of investors. 15 U.S.C. 77bb. New section 2(b)
of the Securities Act requires that when we engage in rulemaking and
are required to consider the public interest as well as the
protection of investors, we also must consider ``whether the action
will promote efficiency, competition, and capital formation.''15
U.S.C. 77b(b).
\8\ H.R. Rep. No. 104-622 (June 17, 1996) at 38.
\9\ S.Rep. No. 104-293 (June 26, 1996) at 15-16.
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III. Proposed Amendments to Rule 701
A. Exemptive Limits
The current rule limits the dollar amount of securities offered to
employees, regardless of how many securities are sold to employees.
Calculations based on offers for this purpose are problematic,
especially in determining how to treat options, warrants, rights and
other exercisable or convertible securities (which represent offers to
sell the underlying securities). In light of our new exemptive
authority, we propose eliminating the restriction in the dollar amount
of securities that may be offered pursuant to the rule since limiting
the amount of offers is not necessary to assure that these transactions
are not so large as to necessitate registration. Instead, a test that
focuses on the amount of sales in each 12-month period should serve
that purpose.
Changing the focus to sales means that issuers no longer will have
to calculate and regularly monitor the amount of options, warrants,
rights or other exercisable or convertible securities, but rather can
focus solely on the amount of securities sold. This change also reduces
the likelihood that companies will restrict eligibility or
participation in a compensatory benefit plan solely to meet an offering
limit. This proposal would make the exemption more usable to a greater
number of companies, including those that maintain deferred
compensation plans, but are not reporting companies under the Exchange
Act and therefore do not qualify to utilize Form S-8.10
Commenters are asked to address whether removing offers from the
calculation is appropriate or whether we should limit the amount of
securities being offered as well as, or instead of, a limit on the
amount of securities sold.
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\10\ 17 CFR 239.16b. Form S-8 is a simplified form for
registering securities for sale to employees but is limited to
public companies which file reports pursuant to the reporting
requirements of the Exchange Act.
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As part of eliminating the ceiling on the amount of offers of
securities that may be made pursuant to the rule, we propose
eliminating outstanding offers from the calculation under the two
formulas for determining the aggregate sales price or number of
securities that may be sold in a 12-month period. By only measuring the
amount of securities sold against the 15% of assets formula or the 15%
of outstanding securities formula, some issuers will be given more
flexibility and an increase in the limit on the amount of securities
that they may sell. The proposal also will greatly simplify a highly
technical calculation and the resulting need for incremental
interpretation. We believe no investor protection concerns are
presented by this added flexibility, but solicit comment as to whether
there might be unanticipated abuses.
Rule 701 has become increasingly of limited utility to larger
companies due to the $5 million limitation. We believe that this would
be the case even if we re-focus the limitation on sales. Moreover, the
more appropriate focus is not the absolute dollar amount sold, but
rather how the amount compares to the size of the company and its
capital base. Therefore, we propose to eliminate the $5 million
aggregate offering price ceiling and rely on the three-part calculation
of the amount of securities that may be sold in a 12-month period to
set a more appropriate dollar limit. In addition, we propose to amend
Rule 701 so that the issuer's most recent balance sheet date would be
used for purposes of that calculation. This would make the measurement
consistent and avoid confusion as to the date to be used when
performing the calculation.11 Comment is solicited as to
whether a specific aggregate offering price ceiling, such as $10
million, $15 million or $20 million, is preferable to no ceiling, and
whether we should change the measurement periods as we propose. We also
solicit comment as to whether non-reporting foreign issuers should be
subject to an annual limit, such as $10 million, because the
application of the calculation to large foreign private companies could
result in the sale of a large amount of securities to a large number of
employees without such companies ever being required to register under
either the Securities Act or the Exchange Act.12
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\11\ Under the current rule, assets are calculated as of the end
of its last fiscal year. The rule is silent as to when outstanding
securities are calculated.
\12\ Domestic issuers that acquire more than 500 shareholders
and have assets exceeding $10 million must register under Section
12(g) of the Exchange Act. Foreign private issuers crossing those
thresholds may instead rely on the exemption from Section 12(g)
provided by Rule 12g3-2(b). 17 CFR 240.12g3-2(b). The rule exempts
from Exchange Act registration securities of a foreign private
issuer if the issuer furnishes to us annual and other reports and
other materials that are publicly available in its home market.
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Comment is solicited as to whether Rule 12g3-2(b) should be amended
so that foreign private issuers that either sell securities under Rule
701 or sell more than some annual threshold amount under the rule, such
as $10 million, would be ineligible for the Rule 12g3-2(b) exemption
since that exemptive relief from reporting under Section 12(g) is
predicated on the foreign issuer not taking any steps to enter the U.S.
market voluntarily.
It is not only the $5 million ceiling that has an obvious limiting
effect; the $500,000 level used in the calculation also has such an
effect. We are particularly concerned that many small businesses are
unnecessarily constrained by this limit. We therefore propose setting
this level of the amount of securities sold in reliance on the rule
during a 12-month period at $1 million. The proposed $1 million limit
should ensure issuers adequate flexibility. Thus, regardless of total
assets or outstanding securities, a private company could always sell
up to $1 million in securities to its employees in a 12-month period.
We note that this level would be consistent with the $1 million
offering exemption in Rule 504 of Regulation D.13 (Unlike
Rule 504, however, securities sold under Rule 701 are ``restricted''
securities and cannot be freely resold.) We request comment on whether
the alternative level allowed under Rule 701 should be limited to $1
million, as proposed, or alternatively whether the amount should be
retained at $500,000 or raised to $750,000, $1.5 million or $2 million.
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\13\ 17 CFR 230.504.
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We propose that the changes in the Rule 701 ceilings would apply to
plans and agreements currently covered by the rule, including those
with consultants and advisors. We do not propose to change the status
of securities sold under the rule, so that the securities would
continue to be ``restricted'' and subject to resale restrictions. We do
not anticipate that the same types of abuses that are associated with
Form S-8, with issuers selling securities to consultants and advisors,
who are in effect underwriters in reselling the securities to the
public, would arise because the securities would be restricted.
However, we solicit comment as to whether Rule 701 should retain
consultants and advisors as eligible participants pursuant to the rule,
whether the current offer and sale ceilings should be retained for
consultants and advisors, and whether the definition of consultant
[[Page 10788]]
and advisor should be narrowed to the definition used with Form S-8.
B. Disclosure to Persons Covered by Rule 701
Similar to some private placements, there is no requirement in Rule
701 to deliver a specific disclosure document to buyers other than a
copy of the relevant compensation plan or agreement. However, because
these transactions are subject to the antifraud provisions of the
federal securities laws,14 we understand that many companies
prepare an offering document to provide information to employee
investors.15 While we are not aware of any widespread
abuses, we are concerned that the increased flexibility added by
today's proposals could lead to a series of larger transactions and
consequently a broader impact on U.S. investors. While it may be
burdensome to impose specific disclosure requirements on small
transactions by small businesses, the cost-benefit balance may shift
because the amended rule would facilitate larger transactions to
potentially unsophisticated employees.
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\14\ See 15 U.S.C. 77q(a) and 15 U.S.C. 78j(b).
\15\ Issuers are reminded of the preliminary note to Rule 701
which reaffirms the obligations of issuers and persons acting on
their behalf to provide disclosure to employees or other persons
within the scope of the rule adequate to satisfy the antifraud
provisions of the federal securities laws.
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We propose that sales of securities under Rule 701 would require
that the employees and other persons covered by the rule be supplied
with recent financial and other information a reasonable period of time
prior to the sale of such securities. We propose that this disclosure
include the risk factors associated with investment in the securities
pursuant to the plan or agreement and the financial statements required
in an offering statement pursuant to Form 1-A of Regulation A under the
Securities Act.16 Regulation A allows for simpler unaudited
financial statements. We also propose that the financial statements be
as of a date no more than 180 days prior to the sale of such
securities.17
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\16\ Form 1-A [17 CFR 239.90] under Regulation A sets forth the
financial and non-financial information required in an offering
statement.
\17\ Proposed Rule 701(g) would provide that the disclosure
delivery obligation would apply a reasonable period of time prior to
the date of sale, but not necessarily at the time offers are first
made. For example, for stock options, disclosure would be required a
reasonable period of time prior to the date of exercise, rather than
at the time of grant or when the option becomes exercisable, and
deferred compensation plans would have a disclosure delivery
obligation a reasonable period of time prior to the date the
employee makes the irrevocable election to defer.
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We do not believe that this limited disclosure would be unduly
burdensome to private companies. In proposing such requirements, we
note that issuers with deferred compensation plans would be required to
disclose the material risks that may be associated with such plans,
such as the risks arising from the unsecured nature of the companies'
obligations.
Commenters are asked to address whether any specific disclosure
requirements should be adopted. In this regard, commenters may want to
address any differences between a disclosure regime for compensatory
purposes and one for capital-raising purposes. Comment also solicited
comment as to whether additional disclosure, such as the other
requirements of Form 1-A, should be required. Commenters should address
whether these disclosure requirements should apply to all Rule 701
sales, or only to those sales that exceed a specified minimum amount
per 12-month period, such as $1 million. That approach would harmonize
Rule 701 with Rule 504.
C. Other Disclosure Approaches
We considered information requirements other than Regulation A,
such as those reflected in Rule 502 of Regulation D.\18\ We decided
however, not to use the Rule 502 requirements because, among other
things, they require audited financial statements and more non-
financial information. They would therefore be more burdensome on these
companies, many of which are small businesses. At the same time, it
does not appear that this level of information should be necessary for
all persons participating in compensatory benefit plans. We also
considered requiring the information requirements of Form SB-1, \19\
which allows small business issuers to offer and sell up to $10 million
worth of securities in any 12-month period under a Regulation-A-type
format, and Form SB-2 \20\ which uses the simplified Regulation S-B
\21\ rules. However, both of those forms also require audited financial
statements as well as more non-financial information than what we
propose. We request comment as to whether other informational
requirements should be utilized rather than the proposed risk factor
and financial, such as those in Rule 502, Form SB-1 or Form SB-2.
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\18\ 17 CFR 230.502.
\19\ 17 CFR 239.9.
\20\ 17 CFR 239.10.
\21\ 17 CFR 228.10 et seq.
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As an alternative, should the level of disclosure to employees
depend on their level of sophistication? For example, executive
officers (as defined by Rule 3b-7 under the Exchange Act), directors
and general partners are very knowledgeable about the company/
partnership and may not benefit significantly from a mandated
disclosure document. ``Officers'' as defined by Rule 3b-2 can be
presumed to be somewhat knowledgeable about the company but may have
less access to company information than executive officers. For this
group, the proposed financial statements and risk factor disclosure may
be appropriate. For more junior employees, former employees,
consultants, advisors, disclosure substantially similar to Form 1-A may
be appropriate.\22\ Would this approach be practical and better protect
those employees who may not have the requisite knowledge about the
company?
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\22\ If this regime were adopted, the private nature of these
companies may justify less disclosure about executive compensation
than you would expect from a public company.
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D. Plain-English Technical and Clarifying Revisions
We also propose to recast Rule 701 by making various non-
substantive technical and clarifying revisions in plain English to make
it more concise, readable and understandable. In this regard, we
propose changes to make it clear that an issuer may combine several
different exemptions under the Securities Act (such as Rule 701 and
Rule 506 \23\), and that Rule 701 is available to plans and agreements
encompassing consultants and advisors that are natural persons without
regard to exclusivity of representation of the issuer, as long as they
render bona fide services that are not in connection with capital-
raising. Comment is solicited on to whether there should be other
changes to make the rule more understandable. Comment also is solicited
as to whether the proposed modifications would be helpful.
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\23\ 17 CFR 230.506.
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E. Other Interpretive Revisions
We would amend the rule in several ways to address a variety of
questions that have arisen since its adoption.\24\ This section
describes each of these proposed changes.
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\24\ Not all staff interpretations need specific changes in Rule
701. For example, although the ability to make offerings to
employees through a trust is not specifically stated in the rule,
the staff has interpreted the rule to allow for such offerings.
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1. Treatment of Affiliates
In the past few years, it has become increasingly commonplace to
sell stock of a private subsidiary to employees of
[[Page 10789]]
a parent or affiliate subsidiary. Given that these transactions appear
to retain the envisioned compensatory aspect, the proposed amendments
would expand coverage to sales to employees of majority-owned
subsidiaries of the issuer's parent (i.e., brother-sister
subsidiaries).
We also understand that some subsidiaries, particularly those
intending to use the rule for deferred compensation arrangements, may
not be able to utilize to great effect the two formulas in the
calculation of the maximum sales per 12-month period. They may not have
sufficient assets or independent business operations to make the ``15%
of assets'' formula meaningful or enough securities to make the ``15%
of outstanding securities'' formula meaningful. Therefore, we propose
to provide that if a parent (whether or not a reporting company) of a
wholly-owned subsidiary fully and unconditionally guarantees the
obligations of the subsidiary, and if such guarantee does not exceed
15% of the parent's assets, the subsidiary can use the 15% of assets
formula with respect to its parent. In that situation, the parent would
deliver its financial statements to satisfy the disclosure
obligations.\25\ Comment is requested as to whether employees of
related companies would be sufficiently informed about their affiliates
such that the information provided would suffice to protect them?
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\25\ Rule 701 would provide that, in limited situations, the
guarantee also would be exempt from the registration requirements of
the Securities Act even though the guarantee may be issued by a
reporting company.
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2. Treatment of Former Employees, Advisors and Consultants
The proposed amendments also would clarify an interpretive question
relating to former employees by specifying that sales may be made to
former employees under the rule. A condition to this treatment would be
that at the time the offer of those securities was originally made the
employee must have been a current employee. Comment is solicited as to
whether companies similarly should be allowed to use the rule to sell
securities to former directors, consultants and advisors.
Historically, the staff has interpreted broadly the definition of
``employee'' and ``consultant'' for purposes of Rule 701.\26\ This
interpretation does not appear to have resulted in any significant
abuses. However, comment is solicited as to whether consultants and
advisors should be restricted from using Rule 701 if they are directly
or indirectly promoting the company's securities. Comment also is
solicited as to whether sales to consultants and advisors who sell the
company's products or services should be limited to those who derive a
certain minimum percentage of their income from sales on behalf of the
issuer, such as 20 percent.
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\26\ See Exceptional Producers Holding Company (August 17,
1989), agents who serve as independent sales representatives for an
affiliate of an insurance company are considered ``consultants and
advisors'' under Rule 701; Golfpro, Inc. (October 3, 1989), golf
pros who serve as independent agents for the distribution of golf
products through their pro shops considered consultants and
advisors; Herff Jones, Inc. (November 13, 1990), Microship
Technology, Inc. (November 4, 1992) and Optika Imaging Systems, Inc.
(October 1, 1996), independent sales representatives for the
distribution of the issuer's products considered consultants and
advisors within the meaning of Rule 701; US Web Corporation
(November 7, 1996), non-employee franchisees considered consultants
and advisors within the meaning of Rule 701; and The Morgan Health
Group, Inc. (December 18, 1995), Princeton Medical Management
Resources, Inc. (September 12, 1997), PHM Management, Inc.
(September 12, 1997) and Talbert Medical Corporation (September 12,
1997), participating physicians who contract to provide medical
services pursuant to various managed care arrangements considered
consultants and advisors within the meaning of Rule 701.
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3. Valuation of Services
The proposed amendments also would simplify the determination of
value of consultant services for purposes of calculating aggregate
sales limit. Rather than retaining different rules for employees and
consultants, such as currently not counting employee services while
counting consultants' and advisors' services, proposed Rule 701 would
treat employee services the same as consultant/advisor services so that
in both cases they would count for determining aggregate sales.
4. Transfers to Family Members
As senior and mid-management personnel receive an increasing
proportion of their compensation in the form of securities, these
investments assume greater significance in the context of estate
planning transactions and other intra-family transfers, such as
property settlements in connection with divorce. Given the common
economic interest of family members evidenced by estate planning
transactions and the non-capital raising nature of these transactions,
we believe that Rule 701 should be available for sales to family donees
of such securities and transferees who receive these securities in
divorce proceedings. Therefore, we propose to amend Rule 701 so that it
is available for immediate family members who have acquired such
securities through a gift or a domestic relations order. For this
purpose ``immediate family'' would be defined as in Form S-8 to include
any child, stepchild, grandchild, parent, stepparent, grandparent,
spouse, siblings, aunt, uncle, mother-in-law, father-in-law, son-in-
law, daughter-in-law, brother-in-law or sister-in-law, including
adoptive relationships, trusts for the exclusive benefit of these
persons, and other entities owned solely by these persons. This
proposal would be consistent with the treatment of transferable
securities pursuant to the pending proposals for Form S-8.\27\
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\27\ See Release No. 33-7506.
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5. Form 701
Should Form 701, a notice filing required to be filed when Rule 701
was first adopted, be reinstituted completely or substantially? How
would this type of information be useful to investors? Should the form,
if reinstituted, be required to be filed electronically on EDGAR?
Should we require that copies of any consultant or advisor agreements
be filed along with or described in Form 701? Would public disclosure
help ensure that only bona fide consultants and advisors purchase
securities from the company under the Rule?
IV. General Request for Comment
Any interested person wishing to submit written comments on the
proposed rule amendments or suggest additional changes or comments on
other matters that might have an impact on the proposals set forth in
this release are invited to do so by submitting them in triplicate to
Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450
Fifth Street, N.W., Washington, D.C. 20549. We request comment as to
the impact of the proposals from the point of view of the public, as
well as the entities required to make available information to persons
covered by Rule 701. We will consider comments on this inquiry in
complying with our responsibilities under section 19(a) of the
Securities Act.\28\ We further request comment on any competitive
burdens that may result from adoption of the proposals. We will
consider comments on this inquiry in complying with our
responsibilities under section 23(a) of the Exchange Act.\29\ Comment
letters should refer to File No. S7-5-98. All comments received will be
available for public inspection and copying in the Commission's Public
Reference Room, 450 Fifth Street, N.W., Washington, D.C. 20549.
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\28\ 15 U.S.C. 77s(a).
\29\ 15 U.S.C. 78w(a).
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[[Page 10790]]
V. Summary of Initial Regulatory Flexibility Analysis
In accordance with 5 U.S.C. 603 we have prepared an initial
Regulatory Flexibility Analysis (``IRFA'') regarding the proposed
amendments.
The analysis notes that we are proposing the amendments to Rule 701
as a result of:
(i) Concerns expressed to us by practitioners;
(ii) Feedback that the current dollar limitations unduly constrain
the ability of many eligible issuers to utilize Rule 701; and
(iii) The specific Congressional mandate expressed in the
legislative history of NSMIA. The purpose of the revisions is to remove
unnecessary constraints. We have determined that the proposed
amendments will not impair investor protection.
As the IRFA describes, we are aware of approximately 1100 Exchange
Act reporting companies that currently satisfy the definition of
``small business'' under Rule 157 of the Securities Act.\30\ The
proposals do not impose any new recordkeeping requirements or require
reporting of additional information. Thus, we believe that the
proposals will not increase reporting, recordkeeping or compliance
burdens, and may reduce those burdens for smaller businesses.
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\30\ 17 CFR 230.157.
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As discussed more fully in the IRFA, several possible significant
alternatives to the proposals were considered. These included
establishing different compliance or reporting requirements for small
entities, exempting them from all or part of the proposed requirements,
or requiring them to provide more disclosure, such as more Form 1-A
items, more information pursuant to Rule 502 of Regulation D or the
full disclosure requirements of Form SB-1 or SB-2. The IRFA also
indicates that no current federal rules duplicate, overlap, or conflict
with the proposed rule amendments.
We encourage written comments on any aspect of the IRFA. In
particular, we seek comment on:
(i) The number of small entities that would be affected by the
proposed rule amendments; and
(ii) The determination that the proposed rule amendments would not
increase (and in some cases may reduce) reporting, recordkeeping and
other compliance requirements for small entities. If you believe the
proposals will significantly impact a substantial number of small
entities, please describe the nature of the impact and estimate the
extent of the impact. For purposes of making determinations required by
the Small Business Regulatory Enforcement Fairness Act of 1996
(``SBREFA''),\31\ we are also requesting data regarding the potential
impact of the proposed amendments on the economy on an annual basis.
Your comments will be considered in the preparation of the Final
Regulatory Flexibility Analysis if the proposed amendments are adopted.
A copy of the Initial Regulatory Flexibility Act Analysis may be
obtained from Twanna M. Young, Office of Small Business, Division of
Corporation Finance, Securities and Exchange Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549.
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\31\ Pub. L. No. 104-121, 110 Stat. 857 (1996)(codified in
scattered sections of 5 U.S.C., 15 U.S.C., and as a note to 5 U.S.C.
601).
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VI. Cost-Benefit Analysis
As an aid in the evaluation of the costs and benefits of these
proposals, we request the views and other supporting information of the
public. We believe that the proposed rule amendments, if adopted, would
result in significant cost savings for issuers without compromising
investor protection. We believe that the expanded use of Rule 701 may
provide significant savings to small issuers and considerable benefits
to compensated persons who in the past may have been deprived of the
opportunity to receive securities as an incentive or in payment for
their services. We note that during the period from mid-1988 through
mid-1993, when persons relying upon the exemption were required to file
a report with us concerning reliance on the exemption, that 1,294
filings were made covering approximately $2.28 billion worth of
securities.
We request your comment on whether the proposed rule amendments
would be a ``major rule'' for purposes of the SBREFA. We have concluded
preliminarily that the proposed rule amendments would not result in a
major increase in costs or prices for consumers or individual
industries, or significant adverse effects on competition, employment,
investment, productivity, innovation or small business. We believe that
those persons who will rely on the rule will not have significantly
increased costs for providing the proposed information since many of
these persons either provide to or have such information readily
available for their employees and other persons covered by the rule
now. We request comments on whether the proposed rule amendments are
likely to have an annual effect on the economy of $100 million or more.
Your comments should provide empirical data to support your views.
VII. Paperwork Reduction Act
Our staff has consulted with the Office of Management and Budget
(``OMB'') and has submitted the proposals for review in accordance with
the Paperwork Reduction Act of 1995 (``the Act'').\32\ The title to the
affected information collection is: ``Rule 701.'' The specific
information that must be included is explained in the rule itself, and
relates to the issuer and the risk factors that may be associated with
investment in securities under the plan or agreement. The information
is needed by prospective purchasers to make informed investment
decisions.
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\32\ 44 U.S.C. 3501 et seq.
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The proposed amendments, if adopted, would increase the flexibility
and utility of Rule 701 for private companies using securities to
compensate their employees.
The collection of information in Rule 701 will be required in order
for companies to use the rule for sales of their securities to their
employees and other persons covered by the rule. The likely respondents
to the rule are those companies that have heretofore utilized the rule,
but were being constrained by its limits and those private companies
who could not utilize the two formulas. While we cannot estimate the
number of respondents that may use expanded Rule 701, there were 1,294
Form 701 filings during the period from mid-1988 through mid-1993, when
persons relying upon the exemption were required to file a report with
us concerning reliance on the exemption. We expect that approximately
300 companies each year will be relying on the exemption. If expanded
Rule 701 is adopted, the estimated burden for responding to the
collection of information in Rule 701 would not increase for most
companies due to the current disclosure requirements in Rule 701, but
may increase slightly for other companies who may not be currently
providing risk factor information and financial statements to employee
purchasers. We estimate that the burden hours per respondent each year
will be two. Therefore, we estimate an aggregate of 600 burden hours
per year.
The information collection requirements imposed by Rule 701 are
mandatory to the extent that a company elects to utilize the Rule 701
exemption. The information will be disclosed to third parties or the
public. We may not require a response to the collection of
[[Page 10791]]
information if the rule does not display a current valid OMB control
number.
In accordance with the Act,\33\ we solicit comment on the
following: whether the proposed changes in the collection of
information is necessary; on the accuracy of our estimate of the burden
of the proposed changes to the collection of information; on the
quality, utility and clarity of the information to be collected; and
whether the burden of collection of information on those who are to
respond; including through the use of automated collection techniques
or other forms of information technology, may be minimized.
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\33\ 44 U.S.C. 3506(c)(2)(B).
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Persons desiring to submit comments on the collection of
information requirement should direct them to: Office of Management and
Budget, Attention: Desk Officer for the Securities and Exchange
Commission, Office of Information and Regulatory Affairs, Washington,
D.C. 20503, and should also send a copy of their comments to Jonathan
G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549, with reference to File No. S7-5 -
98. OMB is required to make a decision concerning the collection of
information between 30 and 60 days after publication, so a comment to
OMB is best assured of having its full effect if OMB receives it within
30 days of publication.
VIII. Statutory Basis, Text of Proposals and Authority
The amendments to our rules and forms are being proposed pursuant
to sections 2, 3(b), 6, 7, 8, 10, 19(a) and 28 of the Securities Act.
List of Subjects in 17 CFR Part 230
Reporting and recordkeeping requirements, Securities.
For the reasons set out in the preamble, title 17, chapter II of
the Code of Federal Regulations is proposed to be amended as follows:
PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933
1. The general authority citation for part 230 is revised to read
in part as follows:
Authority: 15 U.S.C. 77b, 77f, 77g, 77h, 77j, 77r, 77s, 7sss,
78c, 78d, 78l, 78m, 78n, 78o, 78w, 78ll(d), 79t, 80a-8, 80a-24, 80a-
29, 80a-30, and 80a-37, unless otherwise noted.
* * * * *
2. Section 230.701 is revised to read as follows:
Sec. 230.701 Exemption for offers and sales of securities pursuant to
certain compensatory benefit plans and contracts relating to
compensation.
Preliminary Notes
1. This section relates to transactions exempted from the
registration requirements of section 5 of the Act (15 U.S.C. 77e).
These transactions are not exempt from the antifraud, civil liability,
or other provisions of the federal securities laws. Issuers have an
obligation to provide investors with any additional material
information as may be necessary to make the information required under
this regulation, in light of the circumstances under which it is
furnished, not misleading.
2. In addition to complying with this section, the issuer also must
comply with any applicable state law relating to the offer and sale of
securities.
3. An issuer that attempts to comply with this section, but fails
to do so, may claim any other exemption that is available.
4. This section is available only to the issuer of the securities.
Affiliates of the issuer may not use this section to offer or sell
securities. This section also does not cover resales of securities by
any person. This section provides an exemption only for the
transactions in which the securities are offered or sold by the issuer,
not for the securities themselves.
5. The purpose of this section is to provide an exemption from the
registration requirements of the Act for securities issued in
compensatory circumstances. This section is not available for plans or
schemes to circumvent this purpose, such as to raise capital. This
section also is not available to exempt any transaction that is in
technical compliance with this section but is part of a plan or scheme
to evade the registration provisions of the Act. In any of these cases,
registration under the Act is required unless any other exemption is
available.
(a) Exemption. Offers and sales made in compliance with all of the
conditions of this section are exempt from section 5 of the Act (15
U.S.C. 77e).
(b) Issuers eligible to use the rule--(1) General. This section is
available to any issuer that is not subject to the reporting
requirements of section 13 or 15(d) of the Securities Exchange Act of
1934 (the ``Exchange Act'') (15 U.S.C. 78m or 78o(d)) and is not an
investment company registered or required to be registered under the
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.).
(2) Issuers that become subject to reporting. If an issuer becomes
subject to the reporting requirements of section 13 or 15(d) of the
Exchange Act (15 U.S.C. 78m or 78o(d)) after it has made offers
complying with this section, it may nevertheless rely on this section
to sell the securities previously offered to the persons to whom those
offers were made.
(3) Guarantees by reporting companies. An issuer subject to the
reporting requirements of section 13 or 15(d) of the Exchange Act (15
U.S.C. 78m, 78o(d)) may rely on this section if it is merely
guaranteeing the repayment of a subsidiary's securities that are sold
under this rule.
(c) Transactions exempted by the rule. This section exempts offers
and sales of securities (including plan interests and guarantees
pursuant to Sec. 230.701(d)(1)(ii)) under a written compensatory
benefit plan (or written compensation contract) established by the
issuer, its parents, its majority-owned subsidiaries or majority-owned
subsidiaries of the issuer's parent, for the participation of their
employees, former employees, directors, general partners, trustees
(where the issuer is a business trust), or consultants and advisors,
and their immediate family who acquire such securities from such
persons through gifts or domestic relations orders. In the case of a
former employee, this section exempts offers and sales only if the
former employee was employed by the issuer at the time the securities
were offered to the employee.
(1) Special requirements for consultants and advisors. This section
is only available if bona fide services are provided by the consultants
or advisors that are natural persons and the services are not provided
in connection with the offer and sale of securities in a capital-
raising transaction.
(2) Definition of ``Compensatory benefit plan''. For purposes of
this section, a compensatory benefit plan is any purchase, savings,
option, bonus, stock appreciation, profit sharing, thrift, incentive,
deferred compensation, pension or similar plan.
(d) Amounts that may be sold--(1) Offers. Any amount may be offered
in reliance on this section.
(2) Sales. The aggregate sales price or amount of securities sold
in reliance on this section in any consecutive 12-month period, shall
not exceed the greatest of the following:
(i) $1,000,000;
(ii) 15% of the total assets of the issuer (or of the issuer's
parent if the issuer is a wholly-owned subsidiary and the securities
represent obligations that the parent fully and unconditionally
[[Page 10792]]
guarantees), measured at the issuer's most recent balance sheet date;
or
(iii) 15% of the outstanding amount of the class of securities
being offered and sold in reliance on this section, measured at the
issuer's most recent balance sheet date.
(3) Rules for calculating prices and amounts--(i) Aggregate sales
price. The term aggregate sales price means the sum of all cash,
property, notes, cancellation of debt or other consideration received
or to be received by the issuer for the sale of the securities. Non-
cash consideration must be valued by reference to bona fide sales of
that consideration made within a reasonable time or, in the absence of
such sales, on the fair value as determined by an accepted standard.
The value of services exchanged for securities issued to employees, as
well as to consultants and advisors, should be included in the
aggregate sales price.
(ii) Derivative securities. In calculating outstanding securities
for purposes of paragraph (d)(2)(iii) of this section, treat the
securities underlying all currently exercisable or convertible options,
warrants, rights or other securities, other than those issued under
this section, as outstanding. In calculating the amount of securities
sold for purposes of paragraph (d)(1) of this section, count the amount
of securities that would be acquired upon exercise or conversion in
connection with sales of options, warrants, rights or other exercisable
or convertible securities.
(iii) Other exemptions. Amounts of securities sold in reliance on
this section do not affect amounts that may be sold in reliance on
other exemptions, and amounts of securities sold in reliance on other
exemptions do not affect amounts that may be sold in reliance on this
section.
(e) Disclosure that must be provided--The issuer must deliver the
following disclosure to investors a reasonable period of time prior to
the date of sale:
(1) A copy of the compensatory benefit plan or the contract, as
applicable;
(2) If the plan is subject to the Employee Retirement
Income Security Act of 1974 (``ERISA'') (29 U.S.C. 1104-1107), a
copy of the summary plan description required by ERISA;
(3) If the plan is not subject to ERISA, a summary of the material
terms of the plan;
(4) Information about the risks associated with investment in the
securities sold pursuant to the compensatory benefit plan or
compensation contract; and
(5) Financial statements required to be furnished by Part F/S of
Form 1-A (Regulation A Offering Statement) (Sec. 239.90 of this
chapter). Such financial statements must be as of a date no more than
180 days prior to the sale of securities in reliance on this section.
If the issuer is relying on Sec. 230.701(d)(2)(ii) to use its parent's
total assets to determine the amount of securities that may be sold,
the parent's financial statements must be delivered. If the parent is
subject to the reporting requirements of section 13 or 15(d) of the
Exchange Act (15 U.S.C. 78m or 78o(d)), the financial statements of the
parent required by Rule 10-01 of Regulation S-X (Sec. 210.10-01 of this
chapter) and Item 310 of Regulation S-B (Sec. 228.310 of this chapter),
as applicable, must be delivered.
(6) If the sale involves a stock option or other exercisable or
convertible security, the issuer must deliver disclosure a reasonable
period of time prior to the date of exercise or conversion. For
deferred compensation or similar plans, the issuer must deliver
disclosure to investors a reasonable period of time prior to the date
the irrevocable election to defer is made.
(f) No integration with other offerings. Offers and sales exempt
under this section are deemed to be a part of a single, discrete
offering and are not subject to integration with any other offers or
sales, whether registered under the Act or otherwise exempt from the
registration requirements of the Act.
(g) Resale limitations--(1) Securities issued pursuant to this
section are deemed to be ``restricted securities'' as defined in
Sec. 230.144.
(2) Resales of securities issued pursuant to this section must be
in compliance with the registration requirements of the Act or an
exemption therefrom.
(3) Ninety days after the issuer becomes subject to the reporting
requirements of section 13 or 15(d) of the Exchange Act (15 U.S.C. 78m
or 78o(d)), securities issued pursuant to this section may be resold by
persons who are not affiliates (as defined in Sec. 230.144) in reliance
on Sec. 230.144 without compliance with paragraphs (c), (d), (e) and
(h) of Sec. 230.144, and by affiliates without compliance with
paragraph (d) of Sec. 230.144.
By the Commission.
Dated: February 27, 1998.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-5728 Filed 3-4-98; 8:45 am]
BILLING CODE 8010-01-P
